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The first article in our original series explores the advantages of hiring an external CPA firm for the accounting needs of your small business.Read more
Finding an optimized pricing strategy for your small business becomes much easier when you use an outsourced CFO that can offer a fresh, informed perspective.Read more
6 Steps to Success with Pricing in Your Small Business
Posted by Sylvia Lagerquist, CPA
When you lead a small business, there are many essential and critical building blocks to address. Operations, marketing, talent/human capital and accounting are just a few of the top priorities. Along with those is the design, selection and positioning of your products. One often overlooked key to a product’s or service’s success in the marketplace is deceptively simple: its price.
Pricing isn’t just about finding an amount that customers are willing to pay and calling it a day. Prices that are too high can erode your ability to generate sales volume, whereas prices that are too low will cut your cash flow and make it difficult to sustain growth or protect the business in times of difficulty. In addition, pricing is a strategic asset: the prices you charge say a lot about your business and how you want customers to perceive it. Are you the low-cost discounter, the high-priced luxury leader or the value-driven innovator?
With all of these considerations to keep in mind, it’s essential that you take a careful and strategic approach to pricing. Here are six steps that you can use as the foundation of your small business pricing strategy:
1. Begin with intelligence about your customers.
A good place to start in developing your pricing strategy is to get to know your customers. The better you know the potential, present and past buyers of your products or services, the more you can identify factors essential to their buying decisions. For example, do your buyers value your offerings for their immediate use only, or are vendors able to charge higher prices for products or services that deliver lasting value?
Along these lines, you should also identify whether buyers consider your solutions through a unique value lens or with a commodity buying mindset (i.e. lowest price wins). Another more nuanced question to consider is how your buyers budget and pay for what you offer, and what challenges may complicate that process.
In one famous example, tech titan Mark Benioff started Salesforce.com after observing that corporate sales departments typically found themselves unable to purchase high-quality software because companies’ information technology departments traditionally controlled those investments and considered sales a low-priority function worthy of little to no IT spending.
Benioff recognized that his high-value buyers (sales department executives) would pay more for a high-value offering — if only they could free themselves of the corporate IT budgeting and spending process that prevented them from doing so. His solution was to deliver Salesforce.com via the web and charge a low monthly subscription fee — low enough, in fact, that it could be expensed individually or paid for out of a department’s discretionary budget.
And because it was web-based, Salesforce’s product was often exempt from internal IT purchasing requirements since, technically, it wasn’t ‘software’ (in fact, the company’s original tagline was “The End of Software”). This example powerfully demonstrates that a creative and in-depth understanding of your buyer can dramatically impact your success in pricing and customer acquisition.
2. Examine how competitors package.
It’s important to keep in mind that pricing strategy does not operate in a vacuum. Rather, it’s one way in which you communicate value in the marketplace. That’s why examining your competitors needs to go beyond plugging their prices in a spreadsheet and comparing them to yours. Instead, think carefully about how each competitor packages and presents their pricing.
For example, are they selling products or services à la carte or bundled? Do they offer a number of different versions in the same range, each positioned at a different price point? Are they delivering private-label products or services through some distribution channels in order to capture market segments that would otherwise be more price-sensitive? How else are they using marketing and branding to position different value propositions to individual market segments?
3. Examine how competitors match price to value.
What these considerations will tell you is not just how much competitors are charging — but rather, how competitors are using their market knowledge to find the right price point to match their value propositions. Often, this analysis can lead you to a new option that can capture previously untapped market share.
For example, when Hampton Inn hotels were first launched in the 1980s, the U.S. lodging market was generally divided into two categories: low-cost motels and motor lodges at one end, and high-cost, traditional hotels at the other end. The founders of Hampton Inn decided to remove expensive but common components such as a full-service restaurant that were common in the traditional hotels, but kept the high-rise design and higher-end finishes of that same product so that it would not be confused with the motels and motor lodges at the other end of the market.
The result was that they invented an entirely new lodging category — limited-service business-class hotels — which they continue to dominate today. They were able to achieve this by examining how their competitors self-organized and used pricing to define their market segments, then they used that knowledge to create a new segment that they themselves could own.
4. Perform a thorough review of your costs.
One key lesson gained from the Hampton Inn story is that an innovative company can use pricing as part of a strategy to create new market opportunities by changing how they manage costs. Remember that a product you sell that moves in low volumes will be more expensive for you to acquire and carry (or manufacture), because you can’t achieve volume efficiencies or secure quantity discounts as easily. That means that you might be better off selling a high-volume product, or making sure that your low-volume product is unique enough to warrant a higher price tag.
In addition, many small businesses fail to fully account for costs because they mistakenly focus their analysis exclusively on direct costs — i.e. those directly associated with manufacturing or distributing their product. In reality, indirect costs (office, equipment, overhead and administration) can be just as critical to consider. This is especially true for small businesses, since they have lower production volumes over which to spread what are often fixed costs to the enterprise.
5. Develop and deliver a compelling competitive edge.
Now it’s time to put the pieces together. When you’ve thoroughly researched your customers, competitors and costs, you’re ready to craft your competitive edge. Remember that without effective communication, people will usually operate under the impression that having the lowest price makes your product or service the most competitive in a saturated or commoditized market. Because of this, it’s often regarded as fact that consumers will always choose the cheapest option. Not only is this untrue, but it’s also an incredibly dangerous model and could truly do damage to your business.
As a small business, you can’t afford to compete on price alone because your volumes (for products) and human capital/overhead costs (for services) won’t allow you the cost efficiencies necessary to offer the lowest prices and still maintain profitability. In addition, dropping your product’s price drastically enough to become the lowest cost provider sends a message. That message is that you don’t value your offerings, and therefore neither should the consumer.
That’s why you need to build a clear competitive edge, and for smaller firms this is often best sustained on the basis of service. Customers are often willing to pay for extra service and support, which — while expensive to deliver because it involves labor costs — is also easier for small operators to provide as a competitive advantage vs. larger players. You have greater quality control, you can deliver expertise more easily to the customer, and this provides a powerful differentiator. The key is charging for it. If you deliver higher-value service that costs you more to provide, you have to charge a premium — not only to protect profits but also to send the right message that your services indeed provide added value to the customer.
6. Recognize that pricing strategy is your secret weapon.
Pricing is your marketing team’s secret weapon. These numbers make an immediate connection with a consumer — there’s very little guesswork involved. Even in a market of varied budgets, everyone will have a very quick, visceral reaction to whatever prices they’re presented with. Rather than being scared of this power, utilize it. Involve the marketing narrative when you discuss pricing. You can elicit the right emotions in your ideal prospect if you adequately apply a bit of marketing psychology into the process.
As you develop the optimal pricing strategy for your small business, keep this in mind: You can’t sell effectively to everyone, and this means that you can’t price your products or services for everyone either.
Put another way, you simply cannot be more than one business at once. What you can do is research your industry and the people who value it, then discover what your ideal market looks like. Those are the people who will propel your business. Rather than just leading you to success, they will also allow you to sustain it and grow effectively into the future.
Image Credit: Aranami (Flickr @ Creative Commons)
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